Financial tips & advice

What You Need to Understand About Interest Rates

Interest rates are something that goes hand in hand with having a credit card. In a word, interest is simply the profit to the credit card company. Thinking about it from that perspective means that you are thinking about getting the lowest interest rate possible.

When you are just staring out, it’s quite possible to get a very low interest credit card. The credit card company knows that you’re eager to get started, so they can at least offer you a teaser rate. Make sure that if you are going to take on a credit card when you’re still young, you really want to avoid the high interest rates as much as possible. In addition, you want to make sure that you’re not utilizing your entire card. This is a classic mistake that many people make, and it ends up biting them squarely on the rear later on.

If you spend all the way up to your credit card limit, you give the company the impression that you’re about to stop paying and stick them with all of the bills, or that you’re going to end up causing other problems. You just need to make sure that you handle your share of the credit card. Aim for using less than 30% of the total card. Now, we know that isn’t a whole lot, especially on a small card but it’s well worth your time to be cautious.

But let’s talk a little bit more about those interest rates. Most interest is calculated based on the daily average balance.

Need some math? OK!

You need to know the interest rate that you’re working with. For a new person, an interest rate of 9.9% APR isn’t too bad.

This means that any day that you carry a balance on your credit card, you’re going to be charged .0271% for the privilege of doing so. That can really add up over time, which is why you really want to manage those balances as much as possible.

With the power of compounding on the side of the credit card company here, you can actually have more interest than what’s advertised. That’s why it’s so critical to really knowing your credit inside and out. That will ultimately keep you on the right track.

Now, the one advertised isn’t necessarily a lie — but it’s the one that doesn’t take the compounding into consideration. The nominal interest rate is listed in your disclosures and terms — you know, the fine print that you don’t read since you’re out enjoying your new credit card.

Another point about daily compounding that you should be aware of. As the name suggests, this is going to be each and every day that your interest is calculated and added to your balance. Interest isn’t something set aside from your balance — it’s merged right into your purchases. It gets to increase the more time passes. That’s why paying the minimum balance doesn’t move your balance very far at all. You’re just paying the interest and really none of the principal. Every little bit that you remove only leaves space for more to be added. Carrying the balance further just gets you further into debt.

Now, you might be reading this and thinking that credit is an awful and evil thing but that’s not what we’re trying to tell you at all. The truth is that credit really does make a difference. Credit is something that can help you get things that would be out of your reach if you were a cash only customer. However, credit has to be taken seriously.

Keep in mind that you must pay your credit card off on time every month because if you don’t, you’ll end up entering into what’s known as the default rate — which can be as high as 23-29% APR! Do your calculations — that really makes things pretty crazy!

There is something called a grace period on a credit card, and it’s important that you understand that. The credit card company will give you a grace period where you can pay the credit card off completely without the interest kicking in. That’s the grace period in a nutshell — but it doesn’t refer to the time that you have to pay. That’s your due date. The grace period and the due date are going to be different time frames.

Most people are going to carry a balance. When you’re young and you feel that you have plenty of life ahead of you, you might not feel the need to pay your debts in that manner. It’s going to be up to you to keep everything together.

But keeping track of credit early on is a good thing. A lot of people will tell you to avoid banks because of the high fees that come with many accounts, but they think nothing of a credit card. What sense does that honestly make?

If you’re going to think about credit, then you also need to make sure that you also consider an emergency fund. That will make it much easier to not abuse your credit cards when things get tight. And yes, there will be times in life where money is very tight. You just have to think about your options and plan accordingly. Good luck!